The Hidden Cost of Words: The Language of Earnings Presentations and the Differences in Word Usage Based on Stock Returns

By Schieber, Danica; Sherrill, Karen | Southern Journal of Business and Ethics, January 1, 2017 | Go to article overview

The Hidden Cost of Words: The Language of Earnings Presentations and the Differences in Word Usage Based on Stock Returns


Schieber, Danica, Sherrill, Karen, Southern Journal of Business and Ethics


INTRODUCTION

Tesla stock had an IPO price of $17 a share when it debuted in 2010. In mid-year 2016 the price per share was around $200 a share, yet Tesla had never earned a profit. This suggests that investors consider not only what a firm has proven that they can do financially, but what they think a firm is going to do in the future. The top executives of a company should have the best understanding of a company's potential, therefore their comments and the choice of words that they use on the earnings conference calls may influence investors' decisions. In this paper, we examine a particular subset of words associated with credibility and determine if the usage of these words by top executives on earnings conference calls is different if the firms' stock price is performing well versus if the firm's stock price is not performing well. We find a statistically significant difference in usage (frequency counts) of a number of ethos based words between the top performing and poor performing firms. This may serve as a signal to investors.

EXISTING LITERATURE

The top executives of a company typically present the information in their earnings presentations, and should have the best understanding of a company's potential. Therefore, investors pay attention to what executives say on earnings calls. However, it is not only what the executive says, but the choice of words that the executive uses that is important. In many cases, the executives want to portray the company's ethos, or credibility, as very positive, even if their company is not doing well.

Here we use the definition of ethos as provided by Aristotelian rhetoric. In Aristotle's Rhetoric, he defines ethos as "the speaker's personal character when the speech is so spoken as to make us think him credible" (Book I, chap. 2, 1356a). An executive's ethos, or credibility is key to presenting the company as trustworthy and stable. One of the ways that financial executives promote their own credibility is by their word choice.

According to existing research "the purpose of corporate writers is to influence public opinion and attitudes, particularly among potential investors, in ways that create support for organizational practices or undermine opposition to them" (Conaway & Wardrope, 2010, p. 141). Leibbrand (2015) argues that by using the rhetorical appeals (ethos, pathos, and logos), executives can help create value for their listeners and readers in terms of their own credibility in financial discourse.

Similarly, in an analysis of 10-K annual reports from 1994-2006, Loughran, McDonald, and Yun (2008) find that firms that are more likely to use "ethics-related terms," are more likely to be "sin" stocks (e.g. casinos, etc.), are "more likely to be the object of class action lawsuits, and are more likely to score poorly on measures of corporate governance" (p. 39).

According to Bodnaruk, Loughran, and McDonald (2015), the percentage of constraining 10-K words (like "required, obligations, impairment, and covenants") may indicate when a company might "suddenly slip into the realm of being financially constrained" (p. 640). These negative-sounding words may be used by stakeholders as red flags.

Other existing research shows that during times of financial crisis (specifically in the most recent economic crisis in 2009) executives tend to use an optimistic tone with both past and future performance (Patelli & Pedrini, 2014). Using Impression Management Theory, Patelli & Pedrini (2014) find that firms engage in communicative action by using honest disclosure. Specifically, some of the rhetorical strategies they look for include phrases that indicate praise, satisfaction, inspiration, blame, hardship, and denial. By using honesty in their financial documents, executives encourage their stakeholders to trust them. In other research, Yuthas et al (2002) focus on the genre of CEO letters, and find that rhetorically, those specific pieces meet the principles of discourse ethics, like honesty and sincerity. …

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